Why a Global Carbon Market is Coming Sooner Than You Think

Global carbon trading could potentially be the most effective economic tool to regulate industrial CO2 emissions in the fight against climate change.

As concern about global climate change and carbon emissions mitigation is becoming ever more important, governments and corporations across the world have introduced innovative strategies to reduce steadily rising carbon emissions. Some of these strategies such as carbon taxes, energy efficiency strategies, command and control policies and market-based pollution trading mechanisms have been around for some time. However, they were previously used for other pollution control purposes, besides that of carbon emissions mitigation, with varying degrees of success. Nonetheless, since their success in the US to reduce domestic sulfur dioxide deposits in the 1990s, market-based instruments have again risen to the forefront in the fight against climate change.

If an emitter is able to emit less than the regulated amount, then it would be able to sell the difference to other emitters via carbon allowances. Carbon trading thereby incorporates financial incentives for corporations to lower their carbon emissions. Under a cost-benefit analysis, if a carbon emitter can lower its emissions at a lower cost than what it would require to purchase carbon allowances, it will do so. If not, then it will purchase allowances on the open market which would serve to rectify the externalities.

Figure 1: Global Carbon Markets 2005-2011

Due to the amenability of financial inducements in the carbon market for the business sector, the global carbon market has been growing exponentially since its development across the world in the early 2000s. Beginning in 2006, the market has grown robustly to reach a record total of $176 billion by the end of 2011 (Fig 1). Secondary trading allowed this robust increase during 2010 and was able to blunt the impact of the tertiary effects of the global economic crisis, as well as reduce carbon prices.

Globally, the growth in the carbon emission markets expanded in 2011-2012 as European power producers voluntarily purchased more permits before they are obligated to begin repayment for auctions beginning in 2013. Yet, the bulk of carbon trading activity is still in the EU since it accounts for approximately 97 percent of the global trade in certified emissions reductions (CERs). But this unequal distribution is due to change as more countries have begun to implement carbon trading in an aggressive attempt to stem carbon emissions.

Despite international economic turmoil, the global carbon market is performing quite well. The robustness of the carbon market is illustrated through the fact that even though there has been an overall reduction in the number of CERs traded in 2011, a record number of carbon emissions related products were traded (global transaction volumes reached a new high of 10.3 billion tons of carbon dioxide equivalent) in late 2011, despite a fall in prices of EU Allowance Units (EUAS) below $10. Due to the increased liquidity and depth of the CER market, as well as the increased liquidity in the Emission Reduction Unit (ERU) secondary market, trading volumes expanded in 2011. This increase – the second time in three years – came despite the Eurozone crisis.

As stated above, Europe is still the dominant player in the global carbon market. It is expected that this trend will continue through 2020 given that the US and Japan have still not made any progress on national carbon legislation. The World Bank estimated that by 2025, the global carbon trading market would equal approximately $1 trillion, of course, driven mostly by Europe, but with significant growth outside of the EU. Boosted by immense economic potential and amid fears over being left behind, countries outside of the EU are moving ahead with establishing carbon-trading programs.

Some countries, such as Ireland, have even noted a positive impact on its negative debt situation by the introduction of a carbon tax. And, while a carbon tax is somewhat conceptually opposed to the notion of a carbon market, it is still parallel to the development of carbon management strategies globally. And, as discussed below with Australia, a carbon tax can transition to a carbon market at a later date.

Major Development Outside of the EU

Australia became the largest economy outside of Europe to aggressively implement a carbon-trading scheme. Prime Minister Julia Gillard announced a plan in July 2010 that would tax the carbon dioxide emissions of the country’s 500 largest emitters and be a major expansion of carbon trading outside of the EU. The Australian plan is quite ambitious, as it would potentially eliminate 159 million tons of carbon dioxide from the atmosphere by 2020. Initially, Australia will begin with a carbon tax that would affect about five hundred companies including mining giants with operations in Australia such as BHP Billiton, Rio Tinto and Xstrata.

The government initially constructed a carbon price of 23 Australian dollars ($21.83), for each ton of carbon dioxide emitted beginning on July 1, 2012, subsequently increasing by 2.5 percent annually before transitioning in 2015 to a market-driven trading program. The Australian carbon market is expected to be quite lucrative as it is forecast to be worth as much as $15 billion in Australian dollars (USD $14.24 billion) by 2015, with permit sales expected to raise A$25 billion (USD $23.73 billion) in the first four years of implementation. In April 2012, Australian Climate Change minister Greg Combet also predicted that there could be an Asia-Pacific regional carbon-trading platform (with linkage to Australia) as other Asian countries develop their own carbon trading schemes.

The world’s other major economies are watching the movements in Australia closely. Australia also hopes that its ambitious program will provide the impetus needed to ignite a global carbon agreement. There has already been some movement internationally, even prior to the development of the Durban Accord in late 2011. In addition to the potential regional Asia-Pacific carbon market, preliminary negotiations have taken place between the EU and Australia to link their respective carbon emissions trading programs in the future, which would develop the largest collective carbon-trading platform in the world.

Setbacks and Delays to National Carbon Markets

Notwithstanding the optimistic developments in many countries, there were notable setbacks for the global carbon agenda in 2010. That year saw lack of political will to pass federal cap and trade legislation in the US, the world’s largest and most influential market. Meanwhile, Japan’s Basic Act on Global Warming, which passed in the Diet’s lower house, collapsed when the governing party lost control of the upper house a few months after passage. Furthermore, the strong resistance from the Japanese business lobby also caused it to postpone the creation of a carbon-trading scheme until after 2014.

Japan shrugged off criticism of its failure to pass a climate change bill by developing other green measures such as proposing an environmental tax on fossil fuels and promulgating a feed in tariff law for renewable energy. South Korea, which promoted an ambitious carbon abatement plan with its Framework Act for Low Carbon, Green Growth law, delayed implementation in the face of criticism from its powerful export business lobby that other major economies failed to take steps, thus placing South Korea at a competitive disadvantage. In early 2011, South Korea delayed implementation from the initial date of 2013 to a start date of 2015.

Municipalities and States Take Up the Burden

Yet, it must be stated that while the setbacks to various national strategies were daunting, they were more than offset by the action undertaken by state and local governments to act in the place of the national authorities. In the United States, due to the lack of governmental action, state governments began to press for the adoption of carbon abatement programs. In the Northeast of the country, the Regional Greenhouse Gas Initiative (RGGI) was founded by ten states as members with three Canadian provinces acting as observers.

The RGGI implemented its first compliance period in September 2009. On the American West coast, California launched the world’s, up until the time of writing, second largest carbon market in November 2012, covering 85 percent of the state’s emissions and auctioning more than 20 million carbon emission permits. The Californian carbon market will link with Quebec’s in 2013.

While Japan delayed implementation of a national carbon trading scheme, Tokyo moved ahead to become Asia’s first carbon trading initiative. In April of 2010, Tokyo launched its city wide carbon-trading initiative, which would require 1,400 of the city’s most energy and carbon intensive companies to meet legally binding emissions targets, designed after those of the EU ETS.

Carbon Market Development in Developing Countries

The developing world also began to take a serious look at carbon mitigation recently. The world’s largest aggregate carbon emitter per ton, China, indicated that it would implement a national carbon-trading scheme by 2015. China is preparing to launch a pilot scheme in Beijing, Hubei, Tianjin, Shanghai, Chongqing, Shenzhen, and Guangdong — all of them major hubs with a combined population of 250 million people. In addition to the pilot carbon trading scheme, there is also a government policy to limit the national carbon output per unit of GDP by 17 percent before the end of 2015, and to increase the reduction significantly to 40 to 45 percent by 2020.

India implemented a coal tax, while South Africa plans to place carbon caps on its major emitters. Kenya announced in 2010 that it would be a first mover in Africa and create a Nairobi climate exchange, which would mark the start of Africa’s first carbon exchange platform. In Indonesia, the Jakarta Futures Exchange is studying the possibility of setting up a carbon-trading scheme. Indonesian companies are already able to earn carbon offsets through the United Nations’ Clean Development Mechanism (CDM), which allows investors in industrialized countries to invest in clean-energy projects in developing nations. Indonesian officials reason that a carbon-trading program could be lucrative for its economy.

Conclusion: The Birth of the Carbon Market Giant

In certain countries, which have a fairly high-energy intensity rate, such as China and the Gulf countries, carbon trading will be pursued as a means to lower energy consumption rather than due to environmental concerns. In countries where the business sector successfully resisted the early implementation of carbon trading, that opposition has merely added to the delay in the ultimate adoption of such mechanisms.

It appears that by 2015-2020, most of the world’s major economies, and many developing ones, will have some form of carbon trading or abatement program in place. Much of this preliminary movement took place prior to the development of the Durban Accord, which since its adoption as a roadmap in December of 2011, is now likely to accelerate the creation of a global carbon market even further. And, while some observers were unhappy with the progress in Doha (COP 18), in terms of lacking a “grand vision,” Doha was still not a “failure.” Doha created a sense of momentum for another commitment period from 2013-2020. With additional substantive steps undertaken by the world’s major economies, carbon trading is poised to become a major part of the global economic architecture.

Justin Dargin is Middle East energy specialist, and a former Associate with Harvard Kennedy School’s Belfer Center for Science and International Affairs

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